Net working capital arises from lags between the time the firm obtains the raw materials for its product and the time it finally collects its bills from customers. The cash conversion cycle is the length of time between the firm’s payment for materials and the date that it gets paid by its customers.

The cash conversion cycle is partly within management’s control. For example, it can choose to have a higher or lower level of inventories. Management needs to trade off the benefits and costs of investing in current assets. Higher investments in current assets entail higher carrying costs but lower expected shortage costs.